An overhaul of Edgewood Plaza will continue unrestricted despite a developer's "grave error" in knocking down one of two historic buildings that were supposed to be saved, the Palo Alto City Council decided Monday night.

However, Sand Hill Property Co. could still face a substantial financial penalty for the blunder.

The city council voted 6-3 to allow the developer to move forward with six of the 10 homes proposed for the shopping center site. The decision flew in the face of a city staff recommendation to block construction in order to ensure the loss of the historic structure is addressed.

A majority of the council members were concerned about the impact of delaying parts of a project so many years in the making.

"(Sand Hill Property Co.), obviously, is being hurt. It was their actions, though, so they're self-inflicted to some extent. But the neighborhood, the community and the whole entrance to Palo Alto is being hurt with this ... shopping center just in limbo," said Vice Mayor Nancy Shepherd.

If we can get this moving along," she added, "I think that would be in the best interest of Palo Alto."

In addition to new single-family homes, the renovated shopping center will boast a new grocery store and a small park.

The project, which was approved by the city council last year, required a special type of zoning known as "planned community." It allows developers to circumvent building restrictions as long as they provide public benefits. In this case, Sand Hill Property Co. was supposed to save two buildings that were deemed historic in exchange for permission to build housing.

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The 1950s-era shopping center is the only one ever built by noted developer Joseph Eichler.

On Monday night, John Tze of Sand Hill Property Co. accepted blame for the building's demolition, which he said took place without his say-so while he was out of the country last fall.

"I broke a trust," Tze told the city council. "The general (contractor) wasn't authorized by me or the city. It occurred through a failing of my organization. I'm sorry it happened and I take full responsibility."

Council Member Gail Price, who joined Karen Holman and Greg Schmid in casting the dissenting votes, said Sand Hill Property Co. made a "grave error" and should be punished accordingly. Price argued that the housing portion should be held up until the developer completes a legally-required environmental impact report that addresses the loss of the building.

"If we don't do this," she said, "we are not making any reasonable response to what has happened here."

Residents were similarly divided about what should be done. Robert Smith urged the city council to move forward, arguing that the site's failure as an economic center undercuts its historic value.

"I think we'd be better off here to find a way to systematically overlook this, get on with it," Smith said. "I'm suggesting that you show some maturity and common sense and stop talking about punishing and how much you can extract and this and that. We are being punished enough by the blight."

Land-use critic Bob Moss disagreed. He suggested that the developer be ordered to pay $50,000 to $100,000 to upgrade other historic buildings in Palo Alto.

"We have to have a (planned community) that has real public benefits," Moss said. "And we have to have real penalties."

But Elise DeMarzo, who lives on Edgewood Drive and serves as the city's public art manager, said the perpetual construction has been a headache for neighbors of the shopping center.

"I do understand that there was a breach in protocol and there needs to be a penalty for that," DeMarzo said. "What I do not understand is how delaying the construction ... will benefit the community at all."

Sand Hill Property Co. could face a hefty financial penalty later this year when the city council reviews the environmental impact report. Council members asked city staff to craft a fine that is based on a percentage of the money the developer would save by getting to move forward with the housing portion of the project versus having to wait until the report is done.

The amount will likely be much higher than the $10,000 fine suggested in a report by city staff.

"If you do some rough, back of the envelop calculations," Council Member Larry Klein said, "I think you come out with numbers that are not dissimilar to what has been thrown around tonight."